The Effects of Import Quotas on the Steel Industry

Transcription

1 A CBO STUDY The Effects of Import Quotas on the Steel Industry July 1984 Congress of the United States Congressional Budget Office

2 THE EFFECTS OF IMPORT QUOTAS ON THE STEEL INDUSTRY The Congress of the United States Congressional Budget Office

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4 PREFACE The Congress is now considering legislation (S and H.R. 5081) that would impose a quota on steel imports. In response to a request from the Subcommittee on Trade of the House Ways and Means Committee, the Congressional Budget Office (CBO) has prepared this evaluation of the proposed quota and its effects on the steel industry and the economy. The report updates and expands testimony delivered to the subcommittee on June 20, A subsequent study for the subcommittee will examine other policy options available to address conditions in the steel industry. In keeping with CBO's mandate to provide objective analysis, this report makes no recommendations. The report was written by Louis L. Schorsch of CBO's Natural Resources and Commerce Division, under the supervision of David L. Bodde and Everett M. Ehrlich. The econometric simulations were directed by Thomas J. Lutton. Theresa Dailey provided valuable research assistance. The author wishes to thank Janet North, of the American Iron and Steel Institute, for promptly providing up-to-date statistics. Comments on early drafts of the report were received from Joseph Spetrini and Linda Ludwig of the Department of Commerce and James Collins of the American Iron and Steel Institute. The manuscript was prepared for publication by Kathryn Quattrone, Deborah Dove, Betty Jarrells, and Philip Willis, and was edited by Francis Pierce. July Rudolph G. Penner Director

16 SUMMARY The imposition of a five-year, 15 percent quota on steel imports, as called for in H.R and S. 2380, would increase prices, output, and employment in the domestic steel industry but would generate offsetting losses in the rest of the economy. The quota would release substantial sums for investment in the domestic steel industry, although it is questionable whether this would suffice to raise investment to the level that the industry claims is necessary to restore its competitiveness. Moreover, there is little prospect that the quota would reverse the secular decline in the industry, since it does not address the underlying factors that have conditioned this decline. CONDITION OF THE U.S. STEEL INDUSTRY The industry is currently emerging from very depressed conditions in 1982 and 1983, the worst years of the postwar era for U.S. steel producers. In 1982, the industry operated at less than 50 percent of capacity. Shipments and production were lower than at any time since the late 1940s. These conditions precipitated substantial layoffs and industrywide operating losses of about $2.5 billion. Production increased somewhat in 1983 but not enough to offset the 1982 downturn. Financial losses continued at the 1982 pace, and roughly 10 percent of the industry's capacity was permanently retired. During 1983, the industry employed only 60 percent of the labor force it had engaged in These conditions were exacerbated by record levels of import penetration, amounting to over 22 percent of domestic steel consumption in 1982 and over 20 percent in The industry showed significant improvement in the first few months of 1984, and most steel firms are likely to be marginally profitable in this year. But employment has not increased greatly and imports continue to claim roughly 25 percent of the U.S. market. Moreover, the most recent data suggest that the steel market has again weakened during May and 3une. Changes in market conditions do not hit all steel producers with the same impact; the U.S. steel industry is not monolithic. The industry comprises three distinct sectors: integrated producers, specialty steel producers, and "minimills." The brunt of the downturn was borne by the integrated producers, such as the United States Steel Corporation and Bethlehem Steel Corporation. Although these firms have traditionally dominated the industry, their market share has been shrinking since at least xv

17 1960. In contrast, minimills have increased their share of domestic steel production from about 3 percent in 1960 to almost 20 percent today. These firms, which use a different technology, have been highly profitable and highly competitive against both domestic integrated and foreign producers. While minimills were adversely affected by recent weak market conditions, the long-term prospects for this sector are good. Minimills provide the clearest evidence that the industry is undergoing a significant restructuring rather than a uniform decline. They are particularly well adapted to the underlying forces that have shaped the U.S. steel market during the postwar period: relatively slow growth in domestic steel consumption, significant technological changes, and the gradual shift of global steel production and consumption away from the United States. The record levels of import penetration in 1982 and 1983 have led to major efforts on the part of U.S. steel producers (particularly the integrated firms) to achieve some trade restrictions. Since 3anuary 1982, the industry has used U.S. trade laws to file a large number of countervailing duty (antisubsidy) and anti-dumping cases with the International Trade Commission (ITC). In the fall of 1982, these cases led to an arrangement with the European Community, effectively limiting imports from that region to slightly more than 5 percent of U.S. steel consumption. Other countries, such as 3apan, have voluntarily restrained their steel exports to the United States, while several trade cases (particularly against steel producers in developing countries) have been filed with the ITC. The principal thrusts in the drive to limit steel imports, however, have been the legislative effort to restrict imports to 15 percent of the U.S. steel market (H.R and S. 2380) and the "201" case filed with the ITC by the Bethlehem Steel Corporation and the United Steelworkers of America. (Section 201 of the 1974 Trade Act allows the President to restrain imports even if fairly traded provided the ITC finds that imports have been a substantial cause of injury to a domestic industry.) Like H.R. 5081, the steel 201 case, as originally filed, sought to limit imports to 15 percent of the U.S. steel market. The ITC ruled for the petitioners in five of the nine product categories covered in the case, accounting for over 70 percent of U.S. steel shipments. The ITC has recommended the imposition of fiveyear quotas for most of these products, supplemented by tariffs for semifinished shapes and wire products. The President must now decide how to handle these cases. H.R. 5081, on the other hand, represents a more sweeping program of steel import restraints than would be provided through the 201 process. xvi

18 H.R. 5081's EFFECTS ON THE STEEL INDUSTRY CBO has developed a model of the steel industry that makes it possible to estimate the approximate effects of the proposed 15 percent quota on steel imports. Projections generated by this model suggest that the quota might have the following effects: o o o o o o o The average price of steel consumed in the United States would increase by about 10 percent. Domestic steel prices would be roughly 3 percent higher in the first year of the quota and roughly 7 percent higher in the fifth year. The price of imported steel would be roughly 34 percent higher in the first year of the quota and roughly 2k percent higher in the fifth year. U.S. steel consumption would decrease between 4 and 5 percent, Domestic steel shipments would increase by about 6 percent, Steel-industry employment would increase by 6 to 8 percent. The quota would transfer between $1.7 billion (in the first year) and $4.5 billion (in the last year) to the domestic steel industry in the form of pretax profits. o The quota would transfer between $2.3 billion and $1.9 billion annually to foreign steel producers, presuming the U.S. government did not seek to capture this sum through auctioning off import licenses or similar measures. / For steel firms and steel workers, therefore, the quota would have a positive effect. Output and employment would increase, as would steelindustry revenues. H.R includes a provision requiring steel firms to invest "substantially all of the cash flow generated by the steel sector" in steel operations. Since the quota would increase steel firms' pretax profits, it would increase cash flow and, according to the bill's provisions, generate an increase in steel investment. Since cash flow hinges on the tax status of individual firms, it is impossible to project accurately the increase in investment that would occur as a result of the quota. But given reasonable assumptions concerning future tax liabilities, it appears that the quota might raise steel industry investment by $1.5 billion to $2.5 billion annually (in 1983 dollars). xvn

19 EFFECTS ON OTHER SECTORS AND ON THE ECONOMY AS A WHOLE The price increases generated by the quota would affect the U.S. economy's overall performance. For industries that consume large amounts of steel, these effects could be substantial. The Economy as a Whole. According to one study, the projected 10 percent increase in the average steel price would increase the producer price index for intermediate materials by up to 0.65 percent in the first year of the quota. I/ Some indication of the quota's inflationary impact can be inferred from the fact that during 1983 the producer price index for intermediate materials increased by 1.8 percent. It is difficult, however, to translate a 0.65 percent increase in the producer price index for intermediate materials into a corresponding increase in the Consumer Price Index or in the implicit price deflator for the gross national product. Presumably, a 10 percent increase in steel prices would have a smaller effect on more general indexes of inflation. Steel-Consuming Industries. A 15 percent steel quota would lead to losses in employment and output, as well as higher prices, in steelconsuming industries, offsetting the benefits it would create in the steel industry. The quota's effects would be particularly injurious to steelconsuming industries that face international competition, especially since U.S. steel prices are already roughly 20 percent above prevailing world prices. Should foreign countries retaliate against the imposition of a steel quota by restricting a similar value of U.S. exports, the quota's net effect on U.S. employment and output would be negative and substantial. Consumers. Finally, the quota would impose costs on U.S. consumers (except those who work in the steel industry). While these losses are difficult to estimate, they would approximate the total transfer of income to domestic and foreign steel producers and related efficiency losses. The quota would entail efficiency losses of approximately $0.9 billion per year. When added to the income transfers that occur as a result of the quota, this suggests that a 15 percent steel quota would cost U.S. consumers (outside the steel sector) between $4.3 billion and $5.9 billion, in 1983 dollars, for each of the five years the quota was in effect. These costs would rise over the duration of the quota. 1. David 3. Cantor, "Effects of Hypothetical Increases in Steel Prices on the Producer Price Index for Intermediate Materials, December December 1984," Congressional Research Service, April 2, XVlll

20 OTHER CONSIDERATIONS; RESTRAINTS ON IRON-ORE IMPORTS AND IMPLEMENTATION H.R would also limit imports of iron ore to 25 percent of projected domestic supply. In recent years, U.S. iron-ore imports, particularly from Canada, have accounted for roughly 30 percent of U.S. supply. U.S. iron-ore reserves are poorer than those found in countries such as Australia and Brazil. As a result, U.S. ore costs are substantially above those incurred by the world's low-cost iron-ore producers. Even allowing for transportation and associated costs, domestic steel producers relying on U.S. iron ore are at a competitive disadvantage compared with those using imported ore. Similarly, high U.S. iron-ore costs represent a significant disadvantage for U.S. producers facing competition from foreign steel producers. This provision in H.R. 5081, therefore, would work against the bill's underlying goal of improving the competitive performance of the U.S. steel industry. H.R might prove extremely difficult to implement. In particular, several aspects of the bill might raise significant administrative problems. It would require the Secretary of Commerce to develop highly product-specific forecasts of steel consumption and to allocate projected product-specific import tonnages among a large number of countries. It would also require the Secretary of Commerce to monitor steel-industry investment plans, but is not specific as to the criteria that would guide this monitoring. Finally, the costs of H.R could be higher than those discussed above if the elimination of import competition allowed domestic integrated producers to reduce the level of competition in some product lines. xix

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22 CHAPTER I. INTRODUCTION The domestic steel industry is currently emerging from the most severe market downturn of the postwar era. In 1982, steel production and shipments fell to levels not experienced since the late 1940s, while capacity utilization dropped to levels reminiscent of the Great Depression. Market conditions continued to be very weak in The effects of this downturn were compounded by record levels of imports and by the fact that no boom period intervened between the steel industry downturns of 1980 and The direct consequences of the downturn were both severe and predictable. Employment in the industry dropped precipitously; in 1983, steel-industry employment was less than 60 percent of the 1979 level. Many of those laid off are unlikely to return to work in the steel industry. Steel firms also experienced unprecedented financial losses. If the costs of permanently closing facilities are included, gross annual losses in steel production approached $5 billion in both 1982 and As a consequence, capital expenditures fell far below the levels that the industry sees as needed to maintain or improve its competitiveness. Finally, the severe conditions in forced major reductions (about 10 percent) in capacity. Indirectly, the experience is likely to speed the structural changes that are occurring in the steel market. In particular, many of the traditional integrated firms are restructuring, closing outmoded facilities, targeting investment, abandoning product lines in which they are uncompetitive, investigating merger opportunities, and seeking closer relations with foreign producers. The other sectors of the industry were much less debilitated by weak market conditions, thus enhancing their positions within the industry and their long-term market prospects. The downturn in the steel industry is a direct result of economic recessions in the United States and the rest of the industrialized world. The decline in world demand, together with high dollar exchange rates, have placed the domestic steel industry under increased pressure from foreign competition. Imports reached a record 22 percent of domestic consumption in The depressed conditions in the steel industry, in part a result of sales lost to foreign producers, have led to legislative proposals to restrain imports (H.R and S. 2380).

23 These bills are meant to provide the industry with temporary relief from foreign competition so that it can modernize to become more competitive. Proponents are willing to accept the price increases that the bill would generate on the grounds that the quota would reverse the longstanding decline in the competitiveness of the American steel industry. H.R and its companion bill, S. 2380, would establish highly product-specific restrictions on steel imports into the United States. H.R would restrict total steel imports to 15 percent of U.S. steel consumption and empower the Secretary of Commerce to enforce the quota by imposing allowable import levels on countries and regions that export steel to the United States. The quota would last for five years, although the President could extend it for three additional years without Congressional approval. In addition, H.R would limit iron-ore imports to 25 percent of total U.S. iron-ore supply. The bill also contains a reinvestment condition requiring the steel companies to reinvest substantially all of its added cash flow from the steel sector in steel operations during the period in which the quota is in effect. This report assesses the likely economic effects of the 15 percent quota that H.R and would establish. It looks not only at the direct effects of such a quota but also at the background of the U.S. steel industry's current difficulties. In addition, it discusses the industry's longerterm prospects and the extent to which H.R and S could alter those prospects. Chapter II describes the various components of the U.S. steel industry and depicts the market conditions faced by the industry over the past decade. In the main, the statistics presented in Chapter II are drawn directly from primary data concerning output, employment, import levels, profitability, and so on. The chapter also presents various estimates of the cost competitiveness of U.S. producers relative to their principal foreign competitors. The chapter concludes with an assessment of the principal long-term trends that affect the U.S. steel market. The specific goals and provisions of H.R and S are described in Chapter HI. CBO's estimates of the economic effects of a 15 percent quota on steel imports, both in the steel market and in the economy as a whole, are given in Chapter IV. That chapter also discusses the bills' proposed restriction on iron-ore imports, the problems of implementing the quota, and the possibility that import restraints could lead to market abuses by the domestic industry.

24 CHAPTER H. THE U.S. STEEL INDUSTRY: CURRENT CONDITIONS AND HISTORICAL BACKGROUND This chapter depicts current conditions in the U.S. steel industry as well as the historical background to the industry's difficulties. Before turning to these issues, however, it describes the three sectors that make up the industry. THE COMPOSITION OF THE U.S. STEEL INDUSTRY The U.S. steel industry is divided into three sectors, based on differences in product mix and technology. Since the problems and prospects of each sector are different, general steel policies that benefit one sector may be inappropriate for others. The following comments provide a brief description of the three sectors: integrated producers, specialty-steel producers, and minimills. The Integrated Sector Integrated producers are the traditional core of the industry. They are referred to as "integrated" for two reasons. First, they typically own raw materials properties (especially iron ore and metallurgical coal) as well as transportation networks and some manufacturing operations (such as shipbuilding) that use steel. Second, they the integrated technology, which begins with coke ovens and blast furnaces, produces steel in basic oxygen furnaces or open hearth furnaces, and then rolls the steel into finished products. (See Appendix A for a more detailed discussion of steelmaking technologies.) Integrated firms typically own several large plants. (The Inland Steel Corporation, which has a single plant in Indiana Harbor, Indiana, is the major exception to this pattern.) The largest integrated firms, together with their estimated market shares for various years, are listed in Table 1. As the table suggests, the major problems in the industry lie in its integrated sector, which has suffered tremendous losses in market share since Inroads by foreign producers and domestic minimills, which are discussed below, account for this decline. The deterioration in market share has been most precipitous and most longstanding for the United States Steel Corporation, which controlled over 30 percent of the U.S. market in 1950 and only 13 percent in The company's loss of market share from 1950 to 1983 almost

25 TABLE 1. MAJOR INTEGRATED STEEL FIRMS AND THEIR ESTIMATED U.S. MARKET SHARES (In percent) Firm U.S. Steel Bethlehem Steel J&L (LTV) a/ Republic Steel Inland National k/ Armco Wheeling-Pittsburgh / Total SOURCES: Iron Age, "Annual Financial Supplement" (various years) and company annual reports. a. Jones & Laughlin Steel, which became a subsidiary of the LTV Corporation in 1968, merged with Youngstown Sheet and Tube in Data for previous years are combined. b. National Steel merged with Granite City Steel in Data for previous years are combined. c. Merged in Data for previous years are combined. equals total import penetration in More important, that loss has altered the conditions that shaped the American steel industry's culture and behavior throughout most of this century. The decline of the former industry leader reflects the emergence of new competitive conditions that have challenged the traditional integrated firms. I/ 1. See Louis Schorsch, "The Abdication of Big Steel," Challenge (March 1984).

26 Most of the recent facility closings and capacity reductions have occurred at integrated plants. Smaller integrated firms (not listed in Table 1) have also experienced severe financial problems in the 1980s; many have gone into bankruptcy proceedings or have been offered for sale. These include McLouth Steel (in Detroit), Rouge Steel (in Detroit, owned by the Ford Motor Co.), CF&I (in Colorado), and Kaiser Steel (in California). The Specialty-Steel Sector Specialty-steel producers typically melt scrap in electric furnaces to produce alloy, stainless, and tool steels. These are higher-valued, technology-intensive products that are gradually increasing as a share of total U.S. steel output. Whereas alloy and stainless steels accounted for 8 percent of total U.S. shipments in 1963, they comprised 11 percent in Most of the major integrated firms produce some specialty steel; and the largest specialty firms, such as Allegheny Ludlum, may use integrated techniques (blast furnaces and basic oxygen furnaces). Nevertheless, the specialty-steel sector includes a large number of small, specialized producers. Specialty steel is used heavily in such industries as aircraft production and nuclear power, and to a smaller extent in most manufacturing industries (for example, the chrome parts in automobiles). Nonspecialty or "carbon steel" is predominant in such industries as construction, automobile production, machinery production, and canning. While there is no hard and fast boundary between the markets for the two kinds of steel, specialty steel is generally more expensive than carbon steel. Specialty-steel producers make up an obviously related but nonetheless distinct industry from carbon-steel producers. This report concentrates on the carbon-steel industry. The Minimill Sector Minimills are a relatively new force in the American steel industry, although their roots can be traced back to the 1930s. 2j Minimills melt scrap in electric furnaces to produce carbon-grade (nonspecialty) steel, a 2. The gradual recognition of minimills' significance can be traced in J. Wyman, "Steel Mini-mills an Investment Opportunity?" (Shearson American Express, 1980); Office of Technology Assessment, Technology and Steel Industry Competitiveness (1980); and Donald F. Barnett and Louis Schorsch, Steel: Upheaval in a Basic Industry (Ballinger, 1983) O

27 product also made by integrated producers. The output of minimills is typically 100 percent "continuously cast," a technologically advanced process that accounts for less than 25 percent of the steel produced at integrated plants. (See Appendix A.) Since 1960, minimills have increased their share of U.S. steel production from about 3 percent to almost 20 percent. Some integrated producers operate plants that use the minimill technology, but these have generally proved less successful than their independent counterparts. Several of these facilities (Bethlehem Steel's Los Angeles plant, for instance) have been closed or sold in recent years. Minimills are frequently located in the South and West, and they typically rely on local or regional markets for both sales and scrap supplies. Generally, they produce less sophisticated products, and they tend to be nonunionized. There are exceptions to each of these statements, however, and the most aggressive minimill firms (for example, Nucor, North Star, Chapparral, and Raritan) are expanding into new product markets and wider sales regions. In most cases, minimills are highly profitable, technologically advanced, and highly competitive with imports. According to some forecasts, their share of U.S. production could grow to 35 percent by the year / The growth prospects of the minimill sector depend on whether it can overcome the technological barriers that currently restrict minimills 1 entry into new product lines, especially flat-rolled products (sheet and strip). Minimills will be able to produce some flat-rolled products if techniques are developed for continuously casting thin slabs. Most observers expect such techniques to be commercialized within the next three to eight years. Since minimills use a different technology and produce different products, they cannot be viewed as a substitute for the integrated sector of the industry. Their significance lies in what they portend for the ongoing restructuring of the U.S. steel industry namely, that technological changes will probably continue to erode the integrated firms' traditional dominance of the steel market, making the industry much more fragmented in the future than it is now. Moreover, the minimills' managerial approach may provide a useful model even for firms that remain firmly committed to the integrated technology. PRODUCTION AND SHIPMENTS The changes in the steel industry's structure that have occurred during the past 25 years have been accelerated by the severe market downturn in 3. Barnett and Schorsch, Steel, p. 278.

28 1982 and As Table 2 indicates, these years were among the worst in the industry's history, and the downturn in steel was far more severe than could have been predicted from the pattern of past recessions. Steel consumption typically lags economic recovery; and that was the case in 1983, when steel shipments increased only slightly over the 1982 level despite the macroeconomic recovery. During the first five months of 1984, there was strong evidence of an upturn in the steel industry. For the last week in May, total U.S. steel production was 2.12 million tons, an increase of 33 percent compared with the first week of This suggested that 1984 shipment levels might reach 80 million tons, compared with 67.5 million tons in 'jj Capacity utilization has also increased substantially over the comparable 1983 level (in part due to capacity reductions), and there are some indications that prices are increasing as well. More recently, however, output levels have fallen off. THE IMPORT PROBLEM Import penetration in the U.S. market is shown in Table 2. During the past ten years, changes in import share have been caused primarily by fluctuations in steel consumption rather than by changes in import tonnage. Steel imports have been a major factor in the U.S. market since the mid- 1960s, and for most of the period since 1968 some controls have been placed on them. Past Restraints on Steel Imports Since the mid-1960s, the industry's principal response to the problem of deteriorating performance has been to seek some restraint on imports. In 1959, steel imports into the U.S. market exceeded exports for the first time in this century. By 1968, imports approached 17 percent of U.S. consumption, a state of affairs that led to intense lobbying for trade restraints. In 1969, the Nixon Administration responded by negotiating Voluntary Restraint Agreements (VRAs) with Japan and the European Community (EC), which countries committed themselves to restricting their total tonnage shipments to the U.S. market. The VRAs were renegotiated in 1972 and lasted for a total of six years, but in the industry's eyes they were ineffective. Since they were voluntary, the VRAs did not require Japan and 4. The CBO model of the steel industry, discussed in Chapter IV, projects 1984 shipments of 78.5 million tons.

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